Commissioner Of Income-Tax, U.P vs Nainital Bank Ltd on 25 September, 1964

Rewritten Version Notice: This is a rewritten version of the original judgment.

Court: Supreme Court of India

Case Number: Civil Appeal No. 938 of 1963

Decision Date: 25 September 1964

Coram: J.C. Shah, S.M. Sikri, Subba Rao J

In this case the petitioner was the Commissioner of Income‑Tax for the State of Uttar Pradesh and the respondent was Nainital Bank Limited. The matter was decided by a Bench of the Supreme Court of India consisting of Justice J.C. Shah, Justice S.M. Sikri and Justice K. Subbarao. The judgment was delivered on 25 September 1964 and is reported as 1965 AIR 1227 and 1965 SCR (1) 340, with subsequent citations in later reports. The issue concerned whether a loss arising from a dacoity was deductible under section 10(1) of the Indian Income‑Tax Act, 1922 as an incidental loss incurred in the ordinary course of the banking business. The facts recorded that dacoits robbed cash and ornaments valued at Rs 1,06,000 from the Ramnagar branch of Nainital Bank Limited, a public limited company engaged in banking. The bank claimed the amount as a trading loss for the assessment year 1952‑53. The Income‑Tax Officer disallowed the claim on the ground that the loss was not incidental to the bank’s business. The same decision was affirmed by the Appellate Assistant Commissioner and by the Income‑Tax Appellate Tribunal. The matter was then referred to the High Court of Judicature at Allahabad, which held that loss by dacoity was incidental to the banking business and therefore permissible as a deduction under section 10(1). The Revenue appealed to the Supreme Court by way of a certificate under article 133 of the Constitution. The Revenue argued that the risk of burglary was not an incident of banking and that the loss fell on the bank not as a banking operator but merely as an owner of funds. The Court held that cash constitutes the stock‑in‑trade of a banking company and that loss of cash therefore represents a trading loss. However, the Court explained that not every loss incurred in the course of business is deductible; a loss must be incurred in the performance of the business and must be incidental to that performance. Whether a particular loss satisfies the test of inciden­cy is a factual question that must be decided on the basis of the nature of the operations and the nature of the risk involved. The Court observed that the degree or frequency of the risk is of little relevance; what matters is the connection between the risk and the nature of the business. The Court further stated that it is an integral part of banking to keep sufficient money in the bank, duly guarded, to meet the demands of depositors, and that retaining money in the bank is part of banking operations. Consequently, the ordinary risk of embezzlement, theft, dacoity or destruction by fire that accompanies the retention of funds is incidental to the carrying on of the banking business.

The Court explained that keeping money in a bank carries the ordinary risk that it may become the target of embezzlement, theft, dacoity, destruction by fire or similar hazards, and that such risk of loss is incidental to the conduct of the banking business. Accordingly, the loss caused by the dacoity in the present case was held to be incidental to the banking operation. The judgment referred to several authorities that were considered relevant, namely Motipur Sugar Factory Ltd. v. Commissioner of Income‑tax, Bihar and Orissa (1955) 28 I.T.R. 128, Charles Moore & Co. (W.A.) Pvt. Ltd. v. Federal Commissioner of Taxation (1956) 95 C.L.R. 344, and Gold Band Services Ltd. v. Commissioner of Inland Revenue (1961) N.Z.L.R. 467, which were relied upon. The Court distinguished the decision in Badridas Daga v. Commissioner of Income‑tax [1959] S.C.R. 690 and disapproved of Ramaswamy Chettiar v. Commissioner of Income‑tax, Madras I.L.R. (1930) 53 Mad. 904. The matter was a civil appeal under the appellate jurisdiction, specifically Civil Appeal No. 938 of 1963, filed against the judgment and decree dated 19 December 1960 of the Allahabad High Court in Income‑tax Reference No. 1588 of 1956. Counsel for the appellant comprised K. N. Rajagopala Sastri, R. H. Dhebar and R. N. Sachthey, while counsel for the respondent was A. V. Viswanatha Sastri together with Naunit Lal. The judgment was delivered by Justice Subba Rao.This appeal, taken by certificate, raised the question of whether a loss of cash resulting from dacoity could be allowed as a deduction under Section 10(1) of the Indian Income‑tax Act, 1922, for the purpose of computing the assessee’s taxable income in a banking business. The facts material to the issue were briefly summarized. The assessee was Nainital Bank Limited, a public limited company engaged in the banking business and operating several branches, one of which was located at Ramnagar. In the ordinary course of banking, the bank kept substantial sums of money in various safes situated on its premises. On 11 June 1951, at approximately 7 p.m., a dacoity was perpetrated at the Ramnagar branch; the dacoits removed cash amounting to Rs 1,06,000 together with some pledged ornaments and other items. For the assessment year 1952‑53, the bank claimed that amount as a deduction in computing its income from banking, contending that it constituted a trading loss. The Income‑tax Officer rejected the claim, holding that the loss was not incidental to the banking business. The rejection was affirmed by the Appellate Assistant Commissioner of Income Tax and subsequently by the Income‑tax Appellate Tribunal. Upon reference to the Allahabad High Court, a Division Bench held that the loss incurred by dacoity was incidental to the banking business, characterizing it as a trading loss, and consequently affirmed that the assessee was entitled to a deduction under Section 10(1) of the Act. Dissatisfied with that decision, the appellant appealed. The appellant’s counsel argued that the bank’s loss resulted from burglary in the capacity of an ordinary citizen rather than as a bank, and therefore the associated risk was not incidental to the banking business, making the loss ineligible for deduction as a trading loss.

The appellant’s counsel argued that the loss incurred through burglary was not incidental to the banking business and therefore could not be allowed as a deduction for a trading loss. Conversely, the respondent’s counsel maintained that the money taken in the burglary constituted stock‑in‑trade of the banking operation, was kept on the premises as part of normal business practice, and that the risk of such loss was inseparable from the conduct of banking activities; consequently, the loss should be treated as a trading loss deductible under section 10(1) of the Income‑Tax Act. Before addressing the legal principles involved, the Court first set out a concise description of what the banking business entails. Section 5(1)(b) of the Banking Companies Act, 1949 defines “banking” as the acceptance of deposits from the public for the purpose of lending or investment, with such deposits being repayable on demand or otherwise and withdrawable by cheque, draft, order or any other means. Section 5(1)(c) defines a “banking company” as any company that carries on the business of banking in India. Section 5(1)(cc) defines a “branch” or “branch office” of a banking company as any such office—whether called a pay office, sub‑pay office or by any other name—where deposits are received, cheques are cashed, or money is lent, and for the purposes of section 35 includes any place where any activity referred to in subsection (1) of section 6 is conducted. From these definitions it follows that the essence of banking consists principally of receiving deposits, extending advances, collecting repayments, and making further advances, a continuous process that requires the bank to maintain readily available cash on its premises. Nainital Bank Ltd. is a public limited company incorporated expressly to conduct such banking activities, and its Ramnagar branch is one of the locations where this business is carried out. Unlike a private individual, a banking company exists solely for the purpose of banking, and it is therefore inappropriate to assign any other character to its operations. Accordingly, the Court noted that the Ramnagar branch habitually kept substantial sums of cash on its premises in order to meet the ordinary demands of its customers. Established jurisprudence confirms that cash represents the stock‑in‑trade of a banking company. This principle was articulated by the Judicial Committee in Arunachalam Chettiar v. Commissioner of Income‑Tax, Madras, where it was observed that the rationale for permitting the deduction of irrecoverable loans before computing profits of money‑lending is that, for a money‑lender as for a banker, money constitutes his stock‑in‑trade or circulating capital, and he deals in that capital in the ordinary course of his business.

In the decision of Commissioner of Income‑tax, Madras v. Subramanya Pillai, a Division Bench of the Madras High Court explained why allowances for bad debts were permitted in the money‑lending business. The Court observed that in banking or money‑lending operations all monies advanced for interest constitute the stock‑in‑trade of the banker or money‑lender, and that bad and doubtful debts amount to a loss of that stock‑in‑trade. Consequently, such losses have always been treated as trade losses and have been allowed to be set off against receipts. The same principle was later reiterated by the Full Bench of the Madras High Court in Ramaswami Chettiar v. Commissioner of Income‑tax, Madras, and by the Patna High Court in Motipur Sugar Factory, Ltd. v. Commissioner of Income‑tax, Bihar & Orissa. Under section 10(1) of the Income‑Tax Act, a loss of stock‑in‑trade is expressly admissible as a deduction when computing profits. This approach was applied when a payment received from an insurance company for stock destroyed by fire was treated as a trading receipt in the computation of assessable profits, as shown in Green (H. M. Inspector of Taxes) v. J. Gliksten and Son, Ltd. and in Raghuvanshi Mills Ltd. v. Commissioner of Income‑tax, Bombay City. The reasoning follows that if an insurance recovery is regarded as a trading receipt, the portion of loss that is not recovered must likewise be allowed as a trading loss. Similar reasoning was adopted for losses caused by enemy invasion in Pohoomal Bros. v. Commissioner of Income‑tax, Bombay City, and for losses due to white‑ant damage in Hira Lal Phoolchand v. Commissioner of Income‑tax, C.P., U.P. and Berar. From these authorities the Court concluded that cash held by a banking business is its stock‑in‑trade, and any loss of that cash arising in the ordinary course of business, whatever the circumstances, may be deducted as a trading loss in computing the total income of the banking enterprise.

Nevertheless, it was argued that not every diminution of stock‑in‑trade, regardless of its cause, qualifies as a trading loss; the loss must also be incidental to the business. The leading authority on this point is the Supreme Court’s decision in Badridas Daga v. Commissioner of Income‑tax. In that case the appellant, a sole proprietor engaged in money‑lending, suffered a loss when an agent of the firm withdrew large sums from the firm’s bank account and used the funds to satisfy his personal obligations. The balance of the unrecovered amount was written off as irrecoverable at the close of the accounting year. The Court held that the loss resulting from the agent’s misappropriation was incidental to the carrying on of the money‑lending business and therefore permissible as a deduction under section 10(1) of the Act. The judgment emphasized that where a deduction is not specifically provided for in section 10(2), its admissibility depends on whether, considering accepted commercial practice and trading principles, the loss arises out of and is incidental to the business. If that condition is satisfied and there is no express or implied prohibition in the Act, the deduction must be allowed. This principle was applied to the facts before the Court, reinforcing the view that losses incidental to business operations, even when caused by fraud or misappropriation, are deductible as trading losses.

In the case under consideration, an agent of the banking firm withdrew a substantial sum of money in order to satisfy his personal liabilities. The amount that could not be recovered from the agent was subsequently recorded in the firm’s books as an irrecoverable loss at the close of the financial year. The Supreme Court held that this loss, which resulted from the agent’s misappropriation, was incidental to the conduct of the banking business and therefore should be allowed as a deduction when computing taxable profit under section 10(1) of the Income‑Tax Act. Justice Venkatarama Ayyar, speaking for the Court, explained that where a claim for deduction is not covered by the specific provisions of section 10(2), the admissibility of the claim depends on whether, in light of accepted commercial practice and trading principles, the loss can be said to arise out of the business and to be incidental to it. He further observed that once this connection is established, the deduction must be permitted unless the Act expressly or implicitly forbids it.

The judge applied this principle to the facts before him and stated that if the employment of agents is itself incidental to the business, it logically follows that losses incurred because of those agents are likewise incidental to the business. The Court concluded that this principle had been correctly laid down and properly applied to the present facts. Nonetheless, counsel for the appellant relied heavily on a particular passage from a previous judgment, cited as (1) (1947) 15 I.T.R. 205 and (2) [1959] S.C.R. 690, arguing that the present case fell within the illustration contained in that passage. The passage emphasized that a loss deductible under section 10(1) must spring directly from the business and be incidental to it, and that not every loss that has some connection to the business qualifies. It illustrated the point with the example of a thief breaking into a money‑lender’s premises and stealing funds. Although such theft depletes the resources available for lending and therefore constitutes a business loss, the loss is not incurred in the ordinary running of the business but is a loss to the owner of the funds, a distinction that determines whether a deduction is permissible under section 10(1). Counsel argued that the loss in the present matter similarly fell on the assessee not as a banking operator but merely as an owner of funds, invoking the illustration to support the claim for deduction.

The Court observed that the loss in the present matter fell on the bank not as a person engaged in the business of banking but as the owner of funds. It noted that the passage previously quoted referred to a money‑lender and therefore did not apply to a public company that carries on banking operations. In the situation of a money‑lender, any profit earned may be mixed with private funds kept at home and may or may not be invested in the business; such funds are indistinguishable from his other money. By contrast, the Court explained that in the case of a bank, the deposits received constitute part of its circulating capital and, at the moment of the theft, formed part of the bank’s stock‑in‑trade. The Court said that, for a trader, the amount stolen could be regarded as part of the stock‑in‑trade only after it had been invested in the business, whereas for a banking company the stolen amount is automatically part of its stock‑in‑trade irrespective of the company’s intention. This, the Court said, is the essential distinction between the instant case and the illustration previously visualised. While the Court pointed out the distinction, it refrained from giving a definitive opinion on whether the loss in the illustrated case would be treated as a trading loss, and noted that the correctness of that observation would have to be examined when a similar case actually comes before the Court. Before concluding, the Court recorded that it agreed with the earlier decisions in Venkatachalapathy Iyer v. Commissioner of Income‑tax(1), Lord’s Dairy Farm Ltd. v. Commissioner of Income‑tax(2) and Motipur Sugar Factory Ltd. v. Commissioner of Income‑tax(3). The Court highlighted that the ruling in Motipur Sugar Factory Ltd. (3), which it accepted as correct, represents a further development of the law. In that case the assessee was a company engaged in manufacturing sugar and molasses from sugarcane. The company, in compliance with statutory rules, deputed an employee to carry cash for disbursement to sugarcane growers at the place of purchase, and the cash was robbed en route. The Division Bench of the Patna High Court held that the loss of the money arose out of the assessee’s business, stemmed from the statutory requirement to send cash to various purchasing centres for disbursement, and therefore the assessee was entitled to deduct the loss while computing its taxable income under section 10(1) of the Act. The Court emphasized that this was not a case of misappropriation by a servant but a loss caused by robbery of cash that had been entrusted to an employee under statutory rules. The Court also observed that similar entrustment may sometimes arise from custom or practice. What was crucial, the Court said, was that robbery of cash from an employee’s hands was held to be incidental to the assessee’s business. Consequently, the Court questioned why a different principle should be applied when the loss was not caused by robbery of an employee on his way to discharge his duty, but by dacoity committed within the bank’s own premises. The Court pointed out that in one case an employee carried cash for disbursement to growers, and in the other case funds were lodged with the bank under reasonable safeguards for later disbursement to its constituents. If the loss was deemed incidental to business in the former case, the Court reasoned that it should be treated similarly in the latter case.

In the matter before the Court, the loss under discussion did not arise from an employee being robbed while traveling to fulfil his duties, but rather from a dacoity that took place inside the bank’s own premises. In one factual scenario, an employee was entrusted with cash that was to be paid to sugarcane cultivators; in another scenario, the bank itself held funds that were safeguarded for later disbursement to its constituents. The Court observed that if a loss was regarded as incidental to the business in the first scenario, the same treatment should logically apply to the second scenario. The Court then referred to the judgment of the Special Bench of the Madras High Court in Ramaswami Chettiar v. The Commissioner of Income‑tax, Madras (4). In that case, the loss resulted from theft of money that was being used in a money‑lending business and was kept in the business premises. The majority of the Full Bench held that the loss could not be allowed as a deduction in computing income tax because the thieves were not employed as clerks or servants of the assessee at the time of the theft. The Court noted the citations (1) (1951) 20 I.T.R. 363, (3) (1955) 28 I.T.R. 128, (2) (1955) 27 I.T.R. 700 and (4) (1930) I.L.R. 53 Mad. 904, and described this judgment as taking a narrow view of the issue. The Court then contrasted this view with the decision in Motipur Sugar Factory case (1), which had been approved by this Court and involved theft by robbers rather than by an employee. The Court indicated that the Madras decision’s correctness was therefore called into question. Moreover, the dissenting opinion of Justice Anantakrishna Ayyar, which offered constructive criticism of the majority, was preferred by the Court over the majority’s reasoning. Turning to another authority, the Court examined the decision of the High Court of Australia in Charles Moore and Co. (W. A.) Pvt. Ltd. v. Federal Commissioner of Taxation (2). In that Australian case, the assessee operated a departmental store and deposited its daily takings in a bank. Each business morning, the cashier and another employee would escort the previous day’s takings to a bank located about two hundred yards away and credit the amount to the assessee’s account. On one occasion, while en route to the bank, the two employees were stopped at gunpoint and robbed of a substantial sum that formed part of the assessee’s receipts for the previous day. The Australian court held that the loss was incurred in the process of gaining or producing the assessable income for that year, within the meaning of section 51(I) of the Income Tax and Social Services Contribution Assessment Act, 1936‑52. The loss was characterized as neither a loss of capital nor an outgoing of a capital nature, and consequently it was allowed as a deduction from assessable income for that year. The court further observed, “Banking the takings is a necessary part of the operations that are directed to the gaining or producing day by day of what will form at the end of the accounting period.”

In the judgment, the Court explained that the act of banking the day’s receipts, or an equivalent financial procedure that had not been previously devised, was essential to the business. Without such a procedure the business would be unable to replenish its stock‑in‑trade, pay wages and meet other necessary outgoings, and consequently the process of generating assessable income would come to a halt. The Court then identified the occasion of the loss in the present case as the act of banking the money. It observed that there was no difficulty in accepting that involuntary outgoings and unforeseen or unavoidable losses should be allowed as deductions when they represented a casualty, mischance or misfortune that was a natural or recognized incident of a particular trade. The Court set out three principles derived from earlier decisions. First, banking the takings was a necessary part of the operations of the business under consideration. Second, the loss caused by robbery was incidental and relevant to that business because the very procedure of carrying on the business involved the risk that cash could be stolen while in transit. Third, the terms “incidental” and “relevant” referred not to how frequently the risk occurred but to the nature and character of the loss, meaning that the loss had to be connected with the activity of producing income. The Court then referred to the decision of the Supreme Court of New Zealand in Gold Band Services Limited v. Commissioner of Inland Revenue, which applied an Australian High Court decision to a similar situation. In that case the appellant owned a continuously operating petrol service station that was held up by an armed robber, and a substantial sum of money was stolen. The New Zealand Court held that the stolen sum was a loss incurred exclusively in gaining or producing the appellant’s assessable income and was therefore deductible from its gross income. Addressing the argument that a distinction ought to be drawn between a robbery committed on the premises and one committed while the money was being taken to the bank, Justice Haslain observed, citing Rich J. in Commissioner of Taxation (N.S.W.) v. Ash, that no valid principle‑based distinction could be made. He explained that whether the robbery occurred on the premises just before banking or while the employee was in transit to the bank, the occasion for the loss was the ordinary conduct of the business. The cash was on the premises at that particular time, and the possibility of such theft was inherent in the normal operation of the business.

The Court observed that the circumstance described earlier “constituted an attraction to a certain type of criminal, including both the safe‑blower and the armed burglar.” In the matter before it, the situation was even stronger because the money involved had been deposited in the bank, and such deposit was absolutely essential for the bank to continue its ordinary business functions. The Court then set out a concise statement of the legal rule that applied. Under section 1O (I) of the Income‑Tax Act, a loss that arises from the trading activities of a business may be deducted when the profit of that business is computed. However, the Court emphasized that not every loss qualifies for deduction; a loss must have been incurred in the course of carrying out the business’s operations and must be incidental to those operations. Determining whether a loss is incidental is a factual enquiry that must be made in each case, taking into account the nature of the activities that the business conducts and the type of risk that those activities involve. The Court explained that the magnitude of the risk or how often it occurs is not the decisive factor; what matters is whether the risk is connected to the very nature of the business. In the present dispute, the respondent was engaged in the business of banking. The Court noted that a fundamental element of banking is to keep sufficient cash on the bank’s premises, properly guarded, so that the bank can meet the demands of its customers. Keeping cash on the premises is therefore an inherent part of a bank’s operational process. The Court further pointed out that retaining cash within the bank premises inevitably carries the ordinary hazards of embezzlement, theft, dacoity, fire or other similar perils. Such hazards, the Court held, are risks that are incidental to the performance of banking activities. Accordingly, the Court was clearly of the view that the loss suffered as a result of dacoity in this case was incidental to the bank’s ordinary business. Consequently, the Court affirmed that the High Court’s order was correct, dismissed the appeal, ordered the appellant to pay costs, and entered the appeal as dismissed.